The cannabis industry has delivered a lackluster performance YTD (year-to-date). Investors who got in at an expensive valuation are struggling. Their portfolios might take a while to turn green. In some cases, they might even have to write down their losses.
Cannabis stocks in August
Interestingly, the companies haven’t given cannabis investors a reason to remain optimistic. New scandals and illegal practices have made the situation even worse. As a result, investors’ confidence has been shaken in the cannabis industry, which can be seen in the valuations. Investors might have an opportunity to be selective before they buy stocks at attractive prices. We’ll discuss some of the stocks with attractive valuations to find the best cannabis stocks in August.
Where’s the cannabis industry at?
First, we’ll discuss the cannabis industry’s current situation. As you can see in the above chart, the yellow line shows the median forward EV-to-sales multiple. The line consists of 12 cannabis players indicated in the footnote. As of Monday, the median valuation level for the cannabis companies was at 5.5x. The level was almost 10% lower than the average over the past four months.
Which is the best stock?
In terms of the valuation, among the 12 stocks, five were trading higher than the peer median, while seven were trading below the median. Stocks that have consistently traded higher than the median are better. The five stocks that were trading above the median are Canopy Growth (WEED) (CGC), Aurora Cannabis (ACB), Tilray (TLRY), Cronos Group (CRON), and Innovative Industrial Properties (IIPR). In my opinion, these stocks will be attractive when their valuations trend lower than their previous levels. Among the stocks, only Canopy Growth, Tilray, and Cronos Group made it on the list.
Canopy Growth was trading at a forward multiple of 9.2x, which was much lower than its historical average of 14.8x. Tilray was trading at a forward multiple of 11.9x compared to its historical average of 41x. Cronos Group was trading at a forward multiple of 18.1x compared to its historical average of 22.6x.
In contrast, Innovative Industrial Properties was trading at a forward multiple of 17.6x compared to the average of 11.6x. Aurora Cannabis was trading at a forward multiple of 12.5x compared to 10.8x.
Besides looking at the above criteria, we can also look at the EV-to-sales multiple. A stock is attractive when analysts’ forward sales estimates increase but the stock price remains stable. The logic is that the stock price didn’t consider the upward sales revision. We’ll compare analysts’ sales estimate revision and EV movement over the last month.
Using this approach, only three stocks saw an upward sales revision, while the EV fell during the same period. The stocks include Aphria, Cronos Group, and Innovative Industrial Properties. Aphria, Cronos Group, and Innovative Industrial Properties’ sales rose 36%, 20%, and 9%, respectively.
Other factors to consider
The EV-to-sales multiple is one way to determine attractive stocks. However, there are many other considerations for investors. Investors can look at each company’s fundamentals. For cannabis companies, strategic initiatives will be important to capture the sector’s next wave. Investing in value-added products like cannabis oil, vape, cannabis edibles, and cannabis beverages will play a key role.
Investors should also pay close attention to macro factors. Macro factors like the global economy, interest rate movements, and the recent trade war can wreak havoc in the markets. Investors can also follow what seasoned investors have to say about the cannabis industry. For example, Jim Cramer has liked Canopy Growth and Cronos Group for a long time. In contrast, Kevin O’Leary has been skeptical about investing in the cannabis sector. Given the regulatory changes in the US and growing acceptance of the industry as a whole, will O’Leary reconsider investing in the sector?
What could lift the mood?
Generally speaking, the cannabis sector’s valuations have taken a hit due to weak earnings. Recently, Aphria (APHA) posted better-than-expected earnings. OrganiGram (OGI) also reported a positive operating income. In addition, Aurora Cannabis (ACB) raised its guidance for the rest of this year, which lifted the stock. However, there could be more. This week, Tilray (TLRY) will likely release its earnings on Tuesday. Canopy Growth (WEED)(CGC) will likely release its earnings on Wednesday. Tilray and Canopy Growth’s earnings results could lead to more positive changes in the market’s direction.